e600 Billion and Counting:Why High-Tax Countries Let Tax

Havens Flourish

Thomas Tørsløv (U. of Copenhagen)Ludvig Wier (U. of Copenhagen)Gabriel Zucman (UC Berkeley)

November 2017

Introduction

How big is the artificial shifting of profits by multinationalcompanies to tax havens, and who benefits/loses from it?

An important question for:

Study of the redistributive effects of globalization

Measurement of global economic activity

Tax policy and tax enforcement

Our contribution: we analyze new datacapturing profit-shifting to tax havens

Systematic analysis of balance of payments & nationalaccounts data published by tax havens & counterparties

EU tax havens report detailed data to Eurostat →enable to estimate amount of profits artificially shifted

Recent improvement in service trade coverage →enable to estimate which countries lose revenue

→ Comprehensive estimate of size of global profit-shiftingand revenue implications for governments worldwide

Our results: artificial profit-shiftingredistributes tax revenue massively

45% of multinationals’ profits are artificially shifted to taxhavens → more than e600bn in 2015

Global corporate tax revenue loss around e200bnper year ( ≈ 12% of global corporate tax revenue)

Under most sensible apportionment rule, European Unionis the main loser (loses ≈ 20% of its revenue)

Main winners: Ireland, Netherlands, Luxembourg(impose low rates of 2–3%, but on huge artificial base)

The E.U. loses about 20% of itscorporate tax revenue in tax havens

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Lost corporate tax revenue due to artificial profit-shifting (% of corporate tax revenue collected)

Profits shifted to non-EU tax havens

Profits shifted to EU tax havens

Note: This figure shows the amount of tax revenue lost because of the artificial shifting of multinationals' profits to tax havens, as a share of total corporate tax revenue collected in 2015.

The failure of enforcement

Why high-tax countries fail to stop profit-shifting:

Tax authorities have incentives to go after transfermispricing involving other high-tax countries

This crowds out enforcement on tax havens

We analyze new data showing that in practice, almostall enforcement is against other high-tax countries

→ In effect, high-tax countries are stealing fromeach other while letting tax havens flourish

Implications for policy

BEPS reinforces perverse incentives of current system:

Makes it easier to go after profits shifted to otherhigh-tax countries...

... Further crowding out enforcement on 0-taxcountries where bulk of shifting tax place

There is a simple fix to this problem:

Sales apportionment of global profits

Can be done unilaterally

Methodology to estimatethe size and cost of profit-shifting

Main challenge in the literature:little data on what happens in tax havens

Widely used source to study profit-shifting: financialaccounts micro-data (e.g., Orbis) and customs data

Face two key challenges:

Orbis: misses most of the subsidiaries in tax havens

Customs: miss service trade (e.g., intangibles)

→ Big disconnect between public debate (which focuseson 0-tax countries and intangibles) and economic research

Example: Google Alphabet

Google transferred its intangibles to hybrid Irish–Bermudasubsidiary in 2003

In 2015, made $15.5bn in profits in 0-tax Bermuda→ invisible in Orbis

Which country loses tax revenue: US? EU?→ Impossible to tell with available micro data

Which country wins: Bermuda? Ireland? None?

Why do high-tax countries fail to tax these earnings?

Most of Google’s profits are invisible infinancial accounts data

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€ Bn. Google's profits in Orbis

True global profits

Sum of observable profits

Note: This graph shows Google's global consolidated profits, and the sum of the profits made by Google's subsidiaries, as recorded in Orbis. The difference is due to the fact that the subsidiaries where Google makes the bulk of its profits are not visible in Orbis.

Most of Apple’s profits are invisible infinancial accounts data

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€ Bn. Apple's profits in Orbis

True global profits

Sum of observable profits

Note: This graph shows Apple's global consolidated profits, and the sum of the profits made by Apple's subsidiaries, as recorded in Orbis. The difference is due to the fact that the subsidiaries where Apple makes the bulk of its profits are not visible in Orbis.

None of Facebook’s profits are visible infinancial accounts data

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€ Bn. Facebook's profits in Orbis

True global profits

Sum of observable profits

Note: This graph shows Facebook's global consolidated profits, and the sum of the profits made by Facebook's subsidiaries, as recorded in Orbis. The difference is due to the fact that the subsidiaries where Facebook makes the bulk of its profits are not visible in Orbis.

Most of Nike’s profits are invisible infinancial accounts data

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€ Bn. Nike's profits in Orbis

True global profits

Sum of observable profits

Note: This graph shows Nike's global consolidated profits, and the sum of the profits made by Nike's subsidiaries, as recorded in Orbis. The difference is due to the fact that the subsidiaries where Nike makes the bulk of its profits are not visible in Orbis.

How we track artificial profit-shifting

We focus on macro data (more comprehensive thanfinancial accounts micro-data)

Consider two key macro statistics in each country:

π = taxable corporate profits / compensation ofemployees

φ = taxable corporate profits accruing to foreigners /national income

High π: abnormally high profits. High φ: profits are madein foreign-owned subsidiaries.

Abnormal profitability π

π is related to the capital share in the corporate sector α

If no net interest paid by corporations, π = α/(1− α)

With identical technology and α = 25%, all countriesshould have π = 33%

If net interest paid = p% of operating surplus,π = α/(1− α) · (1− p)

If π >> 33%: inward profit-shifting (either throughreal transactions or interest payments)

Corporations in tax havens are abnormallyprofitable

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Taxable corporate profits (% of compensation of employees)

Note: This figure shows the ratio of corporate profits (net of interest paid and depreciation) to compensation of employees, as recorded in the national accounts, in 2015.

Average among non-havens: 34%

Corporate profits accruing to foreigners φ

φ is related to current account balance ca, trade surplust, and net interest received from abroad i (all in % of NI)

ca = (t + i)− φ

Inward profit-shifting (Ireland, Luxembourg, ...):(t + i) > 0 and φ > 0

Outward profit-shifting (U.S., France, ...):(t + i) < 0 and φ < 0

→ These identities summarize how profit-shifting affectsbalance of payments and national accounts statistics

Tax havens run huge trade surplus, allpaid back to foreign parents

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Luxembourg

Ireland

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EU22

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Current account balance (% of gross national income)

Net trade surplus

Net foreign interest received

Net foreign corporate profits

Note: This figure shows the current account balance of a selection of countries, as a share of their Gross National Income in 2015. EU22 is the Euoropean Union minus the 6 EU tax havens (Belgium, Cyprus, Ireland, Luxembourg, Malta and Netherlands).

How we measure artificial profit-shifting

We compute artificial profits by setting πi = π̄ in all taxhavens i

Assumption: all profitability in tax havens above worldaverage π̄ reflects inward profit-shifting

Potential limitation: high πi could be due to otherfactors (technology, bargaining, etc.)

But testable: correlation between πi andforeign-ownership φi

Where profits are abnormally high, theyare all within MNEs → artificial

Luxembourg

Ireland

Malta

Netherlands

Puerto Rico

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Taxable corporate profits / Compensation of employees

Profits accruing to foreigners vs. abnormal profitability

How we allocate the artificially-shiftedprofits across countries

Benchmark allocation: based on which countries importfrom (and pay interest to) tax havens

Focus on high-risk service imports (IP, financialservices, etc.), particularly conducive of shifting

Mimics a sales-apportioned corporate tax base (= howCalifornia, New York, etc., tax profits)

Alternative allocation: based on residence of owner

Mimics a residence-based corporate tax base (= howU.S. has taxed profits so far)

Profit-Shifting to

European Tax Havens

Data for E.U. tax havens

6 EU havens: Netherl., Ireland, Lux., Malta, Cyprus, Belg.

Key advantage: report bilateral data to Eurostat

Service exports more reliable than imports (servicessold from LU to FR person unrecorded in FR: Spotify)

Limitation: miss some profits (hybrid corp,inconsistent definition of residency)

We fix this by forcing consistency with U.S. data onprofits made by U.S. multinationals

Service exports recorded by havens aremore reliable than imports rec by importer

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Exports from Luxembourg to EU22 according to Luxembourg

Imports of EU22 from Luxembourg according to EU22

% of Lux. GNI € Bn. The missing service exports of Luxembourg

Note: EU22 is the European Union minus the 6 EU tax havens (Netherlands, Ireland, Luxembourg, Cyprus, Malta, and Belgium).

Service imports from tax havens areunder-estimated by importers (B2C sales)

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Luxembourg Ireland Belgium Netherlands Malta Cyprus

€ Bn. The missing service exports of the six EU tax havens

Exports to EU22 recorded by exporter

Imports recorded by EU22

At least 30% of the services exported byEU havens go unreported by the importer

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EU22 EU6 Luxembourg Ireland Belgium Netherlands Malta Cyprus

Missing service exports, % of total service exports

Note: Service exports include exports to all EU22 countries (EU26 minus Luxembourg, Ireland, Belgium, Netherlands, Malta, Cyprus).

Some profits made by U.S. MNEs aremissing in EU havens’ national accounts

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Taxable corporate profits (% of compensation of employees)

Missing profits of U.S. multinationals

As reported in the national accounts

Note: The blue bar shows the ratio of corporate profits (net of interest and depreciation) to compensation of employees, as recorded in the national accounts, in 2015. The red bar adds corporate profits missing in the national accounts, computed as the discrepancy between FDI income credits reported by the U.S. and total FDI income debits.

Average among non-havens: 34%

A growing amount of profits is artificiallyshifted to the EU havens

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Taxable corporate profits in Ireland (% compensation of employees)

By applying very low rates on a hugebase, EU havens generate a lot of revenue

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Corporate Income Tax Revenue (% Net National Income)

Note: European Union is the average of France, Germany, U.K., and Italy.

Ireland

European Union

By applying very low rates on a hugebase, EU havens generate a lot of revenue

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% corporate tax revenue collected

Tax revenue gained by EU havens on profits artificially shifted

Tax revenue on artificial profits (l.h.s.)

Tax rate on artificial profits (r.h.s.)

Note: This figure shows the amount of tax revenue collected on artificially shifted profits and the implied rate at which these profits are taxed. The revenue collected on artificially shifted profits are calculated as the amount of revenue collected above the average corporate income tax revenue in all non-haven EU countries (scaled by GNI).

Global Profit-Shifting

Close to 20% of global profits are madeby multinationals abroad

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Multinational profits (% of global corporate profits)

Notes: This figure charts the share of global corporate profits made by multinational corporations. Multinational profits are defined as the sum of portfolio equity and FDI equity income receipts across all countries. We subtract income received by tax havens to avoid double counting. Multinational profits were around €1.4 trillion in 2015, while global corporate profits were around €7.9 trillion.

45% of multinationals’ foreign profits areartificially shifted to tax havens

Non EU havens

EU havens

Ireland

Netherlands

Luxembourg Belgium

Malta

Carribbean

Bermuda

Singapore P. Rico

Hong Kong Switzer.

Rest

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Total EU tax havens Non EU tax havens

Bn. € Profits artificially shifted to tax havens: the global view

Note: This figure shows the amount of taxable profits artificially shifted to tax havens in 2015. The total adds up to 627 billion euros, of which 334 billion is shifted to non EU tax havens, and 293 billion is shifted to EU tax havens.

% of MNE profits

63% of the foreign profits made by USmultinationals are shifted to tax havens

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The share of tax havens in U.S. corporate profits made abroad

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Bermuda (and Caribbean)

Notes: This figure charts the share of income on U.S. direct investment abroad made in the main tax havens. In 2016, total income on U.S. DI abroad was about $450bn. 16% came from the Netherlands, 8% from Luxembourg, etc. Source: author's computations using balance of payments data, see Online Appendix.

Allocating the profits artificially shiftedoffshore: sales vs. residence

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Allocation of profits artificially shifted to tax havens

Benchmark scenario: High risk imports from tax havens

Residence scenario

Note: In the benchmark scenario, offshore profts are allocated proportionally to the sum of high-risk services imported from and FDI interest paid tax havens. In the "residence" scenario, offshore profits are allocated based each country's share of global FDI income credits.

EU and US lose almost 20% of theircorporate tax revenue

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Tax revenue lost due to artificial profit-shifting (% of current corporate tax revenue)

Benchmark scenario: High risk imports from tax havens

Residence scenario

Note: In the benchmark scenario, offshore profts are allocated proportionally to the sum of high-risk services imported from and FDI interest paid tax havens. In the "residence" scenario, offshore profits are allocated based each country's share of global FDI income credits.

EU and US lose about e60bn annuallydue to the artificial shifting of profits

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Benchmark scenario: High risk imports from tax havens

Residence scenario

Tax revenue lost due to artificial profit-shifting (billion of euros)

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Developing countries

Rest of OECD

Note: In the benchmark scenario, offshore profts are allocated proportionally to the sum of high-risk services imported from and FDI interest paid tax havens. In the "residence" scenario, offshore profits are allocated based each country's share of global FDI income credits.

The higher the corporate tax rate, themore profits are shifted

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Lost corporate tax revenue due to artificial profit-shifting (% of corporate tax revenue collected)

Profits shifted to non-EU tax havens

Profits shifted to EU tax havens

Corporate tax rate (avg. 2010-2015)

Note: This figure shows the amount of tax revenue lost because of the artificial shifting of multinationals' profits to tax havens, as a share of total corporate tax revenue collected in 2015. The grey line shows the top statutory corporate tax rates.

The failure of tax enforcement

The perverse incentives involved inenforcing arm’s length prices

High-tax ctries have incentives to go after other high-tax:

Danish tax authority (tax rate 24.5%) can go aftermispricing involving Bermuda (0%) or Germany (30%)

MNEs make it hard to go after Bermuda (they wouldlose revenue) and easy to go after Germany (they win)

Mutual agreement procedures facilitate resolve ofdisputes among OECD countries (eg, Denmark–Ger.)

Most transfer price enforcement is againstother high-tax countries

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EU high tax country EU tax haven

% of total Counterpart in Mutual Agreement Procedures in the EU

Note: The graph plots the distribution of the value of mutual agreement procedures in the EU by counterpart. Mutual agreement procedures are cases in which the country conducting a transfer pricing correction (and thus raises the taxable income in the home country) will approach the counterpart country (the country accussed of having excessive profits) and ask them to lower their tax base. The counterpart is the country that the Danish tax authority argue have received excessive taxable profits. The graph shows that 65% of the value of transfer pricing corrections concerns a high tax country (Non tax haven).

E.U. tax authorities barely attempt to goafter profits shifted to tax havens

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Pct. of total Distribution of Danish transfer price corrections (cases)

Non-EU EU

Note: The graph plots the distribution of the number of transfer price corrections by counterpart. Transfer price corrections are cases in which the Danish tax authority have corrected an intra-group cross-border transfer price and as a result raised the taxable profits of firms operating in Denmark. The counterpart is the country that the Danish tax authority argue have received excessive taxable profits. The graph shows that the counterpart in 40% of the cases is a high tax EU country (Non tax haven) and in 24% of the cases is a non-EU high tax country.

E.U. collects negligible revenue bycorrecting transfer prices involving havens

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Distribution of Danish transfer price corrections (value)

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EU

Note: The graph plots the distribution of the value of transfer price corrections by counterpart. Transfer price corrections are cases in which the Danish tax authority have corrected an intra-group cross-border transfer price and as a result raised the taxable profits of firms operating in Denmark. The counterpart is the country that the Danish tax authority argue have received excessive taxable profits. The graph shows that 65% of the value of transfer pricing corrections concerns a high tax country (Non tax haven).

As settlement is facilitated, high-tax tohigh-tax disputes are growing

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Number of cases

Number of Mutual Agreement Procedures in the OECD

New OECD MAP cases globally

Inventory of OECD MAP cases

Note: The graph plots the development in the number of mutual agreement procedures (MAP cases) in the OECD. Mutual agreement procedures are cases in which the country conducting a transfer price correction (and thus raises the taxable income in the home country) will approach the counterpart country (the country accused of having excessive profits) and ask them to lower their tax base. New MAP cases are cases initiated within a given year. Inventory of MAP cases is the total of cases currently in process, that is both new plus cases from previous years that have not been convluded.

Conclusion

Profit-shifting and weak enforcement areleading to a race to the bottom

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Global corporate tax rates

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The race to the bottom is accelerating

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Reforming the corporate tax

Apportionment of global profits proportionally towhere sales are made

Removes any possibility to shift profits, and anyincentives for real tax competition

Works reasonably well for US States

Can be done unilaterally

Would increase corp tax revenue by about 20% inU.S. and Europe